It is common for employees when leaving employment to be offered or to seek exit terms under a settlement agreement. Under such an agreement employees will typically forego their right to make employment-related claims and will in return be paid a cash sum.
In order for a settlement agreement to be legally binding, an employee must obtain independent legal advice, which the employer will usually pay for.
Set out below are ten tips for employees to consider when considering negotiating a settlement agreement.
Tip 1 – Reason for termination
Your employer need not set out in the settlement agreement the reason for the termination of your employment. If a reason is given, it should be consistent with any reference that your employer is giving as part of the agreement and should also be aligned with the wording of any leaving announcement. The reason for termination may be relevant if you have income protection insurance, for example as part of a house insurance policy. Some insurance policies only payout if the reason for termination is redundancy. The reason for leaving can also determine leaver status in relation to equity/options.
Often employers include wording that termination is “by mutual consent”. Such wording can jeopardise the tax-free status of any ex-gratia payment under the settlement agreement. The safest approach is usually either not to give a reason or to give a reason consistent with any reference wording.
Tip 2 – Termination date
Many draft settlement agreements given to employees contain a termination date prior to when the draft is presented e.g. when informal discussions took place. The termination date (as defined in your settlement agreement) should be a date after you have reached agreement on the terms of the settlement agreement.
The longer you remain employed the more you will get paid, as your settlement agreement will state that you will get salary and benefits up to the termination date.
Therefore, you may want to try and get the termination date pushed back allowing you to remain in employment for a period whilst seeking new employment.
Tip 3 – Holiday pay
We always ask for the number of days of outstanding holiday to be specifically stated in the settlement agreement to avoid any misunderstanding (especially where there is carried over holiday from a previous holiday year).
Where your termination date is extended, this may have the effect of increasing your holiday entitlement.
If you are receiving a payment in lieu instead of you working your notice period, strictly speaking you are not entitled to compensation for the holiday that would have accrued to you during that period but you should still try asking for it.
Tip 4 – Payment in lieu of notice (PILON)
If you are not required to work your notice period you should be offered a PILON. The length of your notice period is usually determined by your employment contract. However, if your contractual notice period is short it can sometimes be increased under statute depending on your length of service. Where there is no signed contract of employment you should argue for the notice period applicable to your peers or the industry norm.
If your employment contract gives your employer the right to make a PILON payment, your employer has the contractual power to pay you in lieu instead of making you work your notice period. Check the wording of any PILON to see whether your employer has to pay you benefits in addition to salary for the notice period.
Sometimes employers will try to pay a departing employee a tax-free lump sum under a settlement agreement in place of making a PILON payment. You should object to this approach because there are very strict HMRC rules which state that usual deductions should always be made from contractual notice pay.
Tip 5 – Reference
There is no legal obligation on an employer to provide a reference.
Unless there has been a serious instance of misconduct employers usually agree to include a clause in a settlement agreement providing that the employer will respond to any request for a reference (in writing or orally) in accordance with an agreed form or reference, usually appended to the agreement.
Short-form references, which give little more information than your dates of employment and job title are commonly used, as sometimes (depending on industry sector) more detailed references can lead a prospective new employer to suspect that an agreed settlement was negotiated by lawyers. A clause should be included in the settlement agreement stating that any statement given to a third party shall not be inconsistent with the wording of any leaving announcement and the reference.
Tip 6 – Confidentiality around the settlement agreement and restrictions on making derogatory comments
Your settlement agreement is likely to include a provision restricting you from disclosing the fact that you reached settlement terms with your employer as well as a restriction on you making any disparaging remarks about your employer. It is always sensible to argue for reciprocal obligations on your employer.
Tip 7 – Restrictive covenants
Restrictive covenants or post-termination restrictions are often included or referenced in settlement agreements to protect the employer. These restrictions are only ever enforceable to the extent that they are necessary to protect the employer’s legitimate business interests.
When considering the terms of any settlement agreement, always compare the compensation on offer in relation (in terms of net pay) to the period during which you will be prevented from working under any restrictive covenants. If an employer seeks to restrict you for a longer period, we will advise you to seek a higher level of compensation or to seek a corresponding reduction in the length of any non-compete.
Senior executives with equity in their employer’s organisation may have signed up to a shareholders agreement which will often contain longer and more enforceable post-termination restrictions than those contained in their employment contracts.
Tip 8 – Bonuses
Unless your settlement agreement expressly provides that you will receive a bonus payment post-termination it is unlikely you will do so. Equally, you will be unable to take action to recover any bonus later because you will have waived your right to do so under the terms of the settlement agreement.
Where you have worked for all or a good proportion of your bonus year and where the bonus amounts are readily quantifiable it is usual practice to request the employer to pay all or a pro-rata sum in respect of your bonus. Outgoing employees should be alert to their employers attempting to end their employment in such a manner so as to prevent the payment of a potential bonus.
Tip 9 – Garden leave
A contract of employment may give an employer the right to place an employee on garden leave. Employers may seek to impose garden leave as a term of the settlement agreement.
If you are placed on garden leave, you will be paid in the usual way and will not be required to attend the office. Equally, your employer may seek to restrict your contact with clients and colleagues. In this situation remember that although you are at home (perhaps in the garden) you remain an employee and are still subject to your employer’s authority. For example, you should not go on holiday in that period without booking time off in the normal way.
Some clients are (subject to the length of the relevant period) more than happy to be on garden leave because they continue to get paid and accrue holiday without having to attend work. Other will object to being kept out of the job market. There can also be issues where there is a lengthy period of garden leave followed by a lengthy period of a restrictive covenant.
Tip 10 – Tax liability
The first £30,000 of a termination payment for loss of employment (including any redundancy payment) can be paid tax-free. Any excess will be subject to deductions.
If the termination date is close to the end of the tax year it may be more tax-efficient to move the termination date into the next tax year or to stagger payments under the settlement agreement into the next tax year.
If you need advice or have any questions in relation to the above, please contact David Greenhalgh, employment law specialist on 020 3603 2177.
This article/blog is for reference purposes only. It does not constitute legal advice and should not be relied upon as such. Specific legal advice about your specific circumstances should always be sought separately before taking or deciding not to take any action.